The stock market looks pretty cheap based on future earnings expectations. Don't be fooled Skip Navigation Markets Business Investing Tech Politics Video Watchlist Investing Club PRO Livestream Menu Key Points The S&P 500 trades around 28x trailing earnings versus 21x forward earnings. Experts say the spread mostly reflects high earnings expectations and doesn't necessarily the market is cheap. If earnings disappoint or multiples fall, valuations could look more stretched. The S & P 500 trades at just 21 times expected earnings over the next 12 months, a forward price-earnings ratio that looks quite reasonable considering the benchmark's trailing P/E is currently 28. It doesn't mean stocks are cheap, experts warned. The spread between the two P/E ratios is rarely this wide except at market extremes like back in 2000, FactSet data shows. It's a sign that investors are really expecting a parabolic move in earnings in the coming year and any shortfall could cause a market pullback. We'll get a clearer idea of whether companies can live up to these big profit expectations when second-quarter earnings reporting season kicks off next week. Companies are likely to give forward guidance with those results. What the spread shows: Stocks aren't cheap The valuation spread matters because it shows how much of the market's valuation case is tied to future earnings growth. "The numerator in both your P/E ratios is the same, boiling down the difference to that between LTM and NTM earnings," Aswath Damodaran, professor of finance at NYU Stern, said in an email to CNBC. LTM refers to earnings over the last 12 months, while NTM refers to expected earnings over the next 12 months. The spread itself may not be the warning. The bigger question is whether Wall Street's earnings forecasts are too optimistic. "A little algebra shows the spread is a direct measure of expected earnings growth," Itzhak Ben-David, a finance professor at Ohio State University's Fisher College of Business, told CNBC in an email. To put it simply, the wider spread shows that today's valuations depend heavily on companies delivering stronger earnings over the next year. Ben-David said that makes today's setup demanding by historical standards. He said median real growth in trailing S & P 500 earnings per share has been about 8% per year since 1989 and growth at the level implied by today's spread has happened in fewer than one in five quarters. All of those cases, he adds, were mostly rebounds from periods when earnings had collapsed, namely periods between 1994 and 1995, 2003 and 2004, 2009 and 2011, and 2021and 2022. "What the market is pricing in today is different: growth of that magnitude starting from earnings that are already at record highs," he said. "So, a wide spread doesn't tell you the market is cheap on forward earnings; it tells you prices are reasonable only under an earnings outcome that, outside of post-recession rebounds, has essentially never occurred in the modern data." John Campbell, a Harvard University economics professor, made a similar...
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